The conduct of financial service providers and advisors and the misselling of financial products are increasingly becoming the focus of media attention. It seems that a side effect of recent falls in stock markets, and the down turn of the world-wide economy, has been that claims against financial advisers are on the rise. Aside from their compliance with rules set down by regulators, IFA's have obvious professional duties to their clients. Most importantly they are bound to exercise reasonable care and skill in implementing client instructions and dealing with investment decisions. Legal advisors to investors facing the pain of heavy losses are increasingly focusing their attention on the role and conduct of the IFA and will seek to pin liability on an advisor whose conduct leaves him exposed or vulnerable to legal claims.

One recent legal decision of the English court (Rubenstein v HSBC, decided in September 2011) looked in detail at issues of negligence on the part of IFA's, and in particular whether losses suffered were directly attributable to the IFA's actions. In Rubenstein, the claimant had approached an IFA to place an investment of £1.25 million. In outline, his requirements were that funds should be readily accessible, the investment should be capable of funding regular withdrawals and it was to offer security for capital. The IFA suggested an investment with AIG. The claimant emailed the adviser stating that he could not afford to accept any risk in the investment of the principal sum and asked for confirmation of what, if any risk, was associated with the AIG product. The response was that the adviser viewed the investment as the same as cash deposited in an HSBC bank account.

3 years after the investment was placed AIG suspended withdrawals (following a run on American banks). Based upon the amount invested, and the amount which the client ultimately recovered, the loss was approximately £180,000.

Two of the main issues which the Court had to decide were:

1. Whether there had been advice given (or whether the business was concluded on an execution only basis) and if so whether that advice had been negligent; and
2. Assuming that it was found that negligent advice had been given, was the loss occasioned as a direct result?

In assessing 1 above, the Court looked carefully at the regulatory framework placed upon advisers in England, which is not dissimilar to that under which Isle of Man based IFA's operate. In particular the Court placed great weight upon the requirement (per English conduct of business rules) that any advice etc. provided to a client should be the most suitable and also clear, fair and not misleading. Within this context, the distinction between whether an adviser provides advice or execution only business is fundamental.

In Rubenstein, although there had been no completion of a "fact find", "know your customer" documentation or an "assessment of risk" by the IFA, the Court found that the adviser had learned enough from the claimant to know most of what he would have gleaned had those procedures been followed. The Court then set out what it considered to be the definition of giving advice:-

"The key to the giving of advice is that the information is either accompanied by a comment or value judgment on the relevance of that information to the client's investment decision, or is itself the product of a process of selection involving a value judgment so that the information will tend to influence the decision of the recipient. In both these scenarios the information acquires the character of a recommendation.

To attempt any greater definition of the giving of advice in an investment context would be unwise and is probably impossible. I suggest, however, that the starting point of any enquiry as to whether what was said by an IFA in a particular situation did or did not amount to advice is to look at the enquiry to which he was responding. If a client asks for a recommendation, any response is likely to be regarded as advice unless there is an express disclaimer to the effect that advice is not being given. On the other hand if a client makes a purely factual enquiry such as "What corporate bonds are currently yielding x%?" or "How does this structured product work?", it is not difficult to conclude that a reply which simply provides the relevant information is no more than that.

The test is an objective one. It is irrelevant whether [the IFA] thought he was only providing information or whether Mr Rubinstein thought he was being given advice. The question is whether an impartial observer, having due regard to the regulatory regime and guidance, and to what passed between the parties, would conclude that advice had been given."

The Court found that there had been advice. This was notwithstanding the fact that there had been very little communication between the parties, and no direct comparisons made between different financial products or even between funds which could be held within the AIG product. The emailed question of the client indicating that he could not accept any risk, and the response from the IFA indicating that he viewed the investment as the same as cash deposited with HSBC, was found to be material in terms of whether the client understood that advice was being given.

It having found that advice was given, the next question was whether or not that advice was negligent. The Court found that it was for a number of reasons. First, it was wrong of the IFA to equate the investment as being the same as a cash deposit. Second, the IFA made no attempt to consider other funds which were available within the AIG product as possible alternatives (if he had, the Court opined that it was likely an alternative investment would have been suggested). Finally, and most importantly, the Court found that there had been a breach of the conduct of business rules relating specifically to suitability etc.

The Court then had to assess the issue of whether the loss was attributable to the negligent advice. It said:-

"Since the autumn of 2008 we have become accustomed to economic bombshells of a kind not seen since the great depression. We are now reconciled to the fact that a sovereign state within the Eurozone has defaulted. We have now witnessed the downgrading of the AAA credit rating of the United States. The suggestion that either of these events was going to occur would have been regarded as fanciful [at the time of the investment].

The suspension [of the AIG investment] was triggered by a volume of requests for withdrawal of funds…which was greater than that which AIG Life had received in any previous three month period. The run on the fund was triggered by a well founded rumour in the US financial markets that AIG was going to go bankrupt. The idea that one of the world's largest insurance companies might go bankrupt was unthinkable [at the time the investment was placed], just as it was unthinkable then that one of the UK's major clearing banks might find itself unable to repay depositors…the concept of a run on AIG was "so remote that no financial adviser would have been required to point it out as posing a risk to capital".

Therefore the Court found that the negligent advice did not cause the loss. The loss was not reasonably foreseeable and so was too remote in law to be recoverable in damages. However, this did not mean that a loss could not be claimed as a result of the breaches of the Conduct of Business Rules which there had been (see above). In particular the breaches of those Rules requiring clear, fair and not misleading and most suitable advice were found to be instrumental in persuading the client to invest in the product recommended.

Rubenstein is a timely reminder of how comparatively easy it could be for advisers to find themselves on the wrong end of a claim, and also the types of claim IFA's may face as a result of any breaches of duty etc. There are a number of legal grounds for claims under which professional advisers can find themselves liable:-

Breach of Contract.

This is perhaps the most obvious. A liability will arise if the actions of an IFA are in breach of the terms of the agreement which they have entered into with their client. For example, if the IFA agreed to report on investment returns and provide alternative proposals for investments on a yearly basis but then failed to do so.

In times where the risk of contractual claims may be heightened, additional care should be taken by IFA's to ensure that their contractual terms provide them with the best possible degree of protection, but without unduly stifling their ability to do business.

Misrepresentation.

There are various categories of misrepresentation. Misrepresentation may be fraudulent or negligent. If representations are made to a client recklessly or carelessly without checking the veracity of them, a client who acts upon them and then suffers loss is likely to have a case against the IFA based in misrepresentation.

Negligence.

An IFA owes a professional duty of care to its clients. If the IFA acts in such a way that it breaches this duty, a claim in negligence may lie with respect to any consequential damage suffered. The loss which flows from the negligence must not be too remote, as was found in Rubenstein. The test is that of a reasonably competent financial adviser; i.e. was the standard of care/advice given by the IFA below that of a reasonably competent IFA?

Breach of statutory duty.

Certain statutory provisions impose duties on an IFA. A breach of duty can arise for example as a result of the IFA's failure to follow rules which have legal force (for example the Isle of Man Financial Services Rule Book 2011).

In addition to the various instances of legal liability outlined above, it should also be noted that if an IFA is a director or secretary of a company, then this may constitute grounds for the Financial Supervision Commission in its regulatory role to bring director disqualification proceedings under the Company Officers (Disqualification) Act 2009. Any person who is found to be unfit to act as a company director may be disqualified from acting in such capacity for between 2 and 15 years.

It is imperative at all times that advisers are cognisant of the legal principles and rules under which they are required to operate. It is also vital, and a relatively simple exercise, for advisers to put in place safeguards to ensure that their exposure to legal claims can be effectively managed and any risks kept to a minimum. For example:-

• Always fact find thoroughly.
• Be aware of, and regularly review your contract terms.
• Handle the provision of any advice to clients with extra care and have a standardised procedure in place for it.
• Keep up to date with market developments and professional development.
• Keep proper and complete records.
• Be transparent.
• Communicate with the regulator when necessary.

By taking appropriate action and putting appropriate procedures in place, the likelihood of legal claims arising in an increasingly hostile environment can be effectively minimised.

Damian Molyneux is an Advocate with M&P Legal with particular interest and expertise in relation to financial services industry related legal action and claims (both pursuing and defending). In addition to his professional legal qualifications, Damian worked for over 10 years in the financial services industry, including for Skandia Life Assurance and as an independent financial adviser.

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